What's new
　　Pacific Basin Shipping (PBS) announced operating data for 3Q22: Average daily time-charter equivalent (TCE) of Handysize and Supramax vessels fell 3% and 27% YoY to US$23,620 and US$26,640, down 10% and 21% from 1H22. With effective cost control and order management, the firm's average daily revenue was higher than the market average. The TCE of the firm’s Handysize and Supramax vessels outperformed the market index by US$7,610 and US$7,900 in 3Q22, and that in the past 12 months outperformed the market index by US$4,540 and US$8,770.
　　Comments
　　Freight rates bottomed out in September; watch upside in freight rates and profits. Freight rates were weak in the dry bulk market in 3Q22 despite 3Q being the traditional peak season as dry bulk demand weakened due to COVID-19 resurgence in China, decrease in grain exports in the Black Sea region as a result of the Russia-Ukraine conflict, slow start to the cargo season in the US, and falling container shipping rates weighing on the demand for small bulk shipping. We note that freight rates in the dry bulk market have started to stabilize and rebound since September thanks to the significant increase in domestic coal output and the longer shipping distance due to growing demand in Europe for non-Russian coal. However, we suggest watching three factors in the dry bulk market during the peak season in 4Q22: 1) The peak season of grain exports in the Americas in 2H22; 2) increased coal imports in Europe due to energy shortage; and 3) the support of China's pro-growth policy for dry bulk demand.
　　Long-term supply and demand conditions in the dry bulk market continue to improve. We note that there have been concerns about demand in the market, but the supply of the dry bulk fleet continues to optimize, laying the foundation for a steadily growing market. New shipbuilding orders fell 62% YoY, and the orderbook to fleet ratio is at a record low of 7% as of September 2022. We believe that until new technologies mature, carbon-emission related regulations (such as EEXI and CII, which will come into force in 2023) and tight shipyard capacity (due to strong container shipping earnings and increase in shipbuilding orders) would further dampen the appetite for shipbuilding among small bulk operators. We believe shipping capacity will decline further tightening of environmental regulations due to the higher proportion of older small vessels (old vessels aged over 20 years represent 14% and 10% of Handysize and Supramax fleets as of September 2022). Moreover, we see further restriction in supply as existing fleets need to meet regulatory requirements via upgrading or lowering speed of sailing.
　　Financials and valuation
　　Considering the falling freight rates in the dry bulk market, we lower our 2022 and 2023 net profit forecasts 15.6% and 25.7% to US$810mn and US$770mn. The stock is trading at 2.1x 2022e and 2.3x 2023e P/E. Maintain OUTPERFORM. We cut our TP 57.5% to HK$3.41 due to falling freight rates and average valuation of the sector, as well as interim dividend payout of HK$0.52/sh. Considering dividend payment, we lower actual TP by 36.6%, implying 2.8x 2022e P/E and 3.0x 2023e P/E with 32.0% upside.
　　Risks
　　Weakening dry bulk demand due to economic recession.